Day of reckoning for subprime-hit banks

WASHINGTON (Reuters) - It is confession season for the world's big banks as they finalize 2007 results and try to account for the full scale of the subprime-spawned credit upheaval that threatens to stall the global economy.

Over the next two weeks, most major U.S. banks will file annual reports with the U.S. Securities and Exchange Commission, and several of Europe's biggest financial firms will release 2007 earnings statements.

For some, it will be the first audited reckoning of how badly they were burned by the market turmoil that began with defaulting U.S. subprime mortgage loans.

Those reports should go a long way toward clarifying banks' financial positions as of year-end. Figuring out how far the credit crisis will spread is much harder, and may determine whether the world economy is heading for recession.

Banks buried in bad debts have less leeway to lend to the consumers and companies that drive the economy. Banks have also grown wary of lending to each other because of uncertainty about which firms face heavy losses.

Full disclosure is a critical step in the process of restoring global markets to good working order. That was the point hammered home earlier this month when finance leaders from the Group of Seven rich nations met in Tokyo.

"We need to keep encouraging our financial institutions to recognize their losses, let the market work, and raise capital," Treasury Secretary Henry Paulson told Congress on Thursday. "We don't want to see them ... pull back from doing the things they need to do in the economy."

To date, major banks have disclosed more than $140 billion in losses tied to mortgages, complex debt and other bad credits. German Finance Minister Peer Steinbrueck said total write-offs may reach $400 billion, suggesting that the barrage of bad banking sector news is likely to continue.

The deadline for most publicly traded U.S. banks to file annual reports with the SEC is February 29. Although many already revealed heavy losses when they issued fourth-quarter results in recent weeks, these final year-end reports face closer scrutiny from accountants and could contain some new shocks.

Last week, insurer American International Group Inc (AIG.N) disclosed potential losses in its derivatives portfolio and said its accountants concluded that there was a material weakness in its internal controls over financial reporting.

European banks slated to report earnings this week include Barclays (BARC.L), BNP Paribas (BNPP.PA), and Societe Generale (SOGN.PA). Last week, Swiss bank UBS (UBSN.VX) reported a net fourth-quarter loss of $11.3 billion and revealed that it had tens of billions of dollars in exposure to U.S. mortgage loans, leveraged finance and other potentially risky categories.

$1 TRILLION IN LOSSES?

Kenneth Rogoff, an economics professor at Harvard University and former chief economist of the International Monetary Fund, said subprime-related write-offs are just the beginning. With losses from commercial real estate defaults, unpaid credit card bills, auto loans, corporate debt and other items added in, the grand total may top $1 trillion.

"We haven't by any means seen everything," Rogoff said. "If it were just the subprime debt, it wouldn't be so bad. We're just entering the (U.S.) recession, so the defaults are just beginning."

Rogoff recently co-wrote a paper comparing the current banking woes to five of the biggest financial crises of the 20th century, including Japan's so-called "lost decade" that began in 1992. He found that the current U.S. housing-fed crisis was following a strikingly similar pattern.

The crises were marked by a swift rise in asset prices, mounting debt and steep current account deficits. The run-up in the U.S. housing market from 2003 to 2006 was even steeper than the average asset price rises in the other five crises.

Rogoff sees some disturbing similarities between the path of the U.S. housing market and those in Spain, Britain and Ireland. He dubbed Spain the "Florida of Europe," noting that both were popular with retirees, second-home buyers and speculators who helped drive up property values. Now, both are at the regional epicenter of the housing slump.

EURO ZONE VULNERABLE

Torsten Slok, an economist at Deutsche Bank, said Europe looks particularly vulnerable to the fallout from the global credit contraction because interest rates are higher there than in the United States.

While the Federal Reserve has reduced rates by 2.25 percentage points since mid-September, the European Central Bank has held steady. The ECB recently shifted its stance from worrying primarily about inflation to concerns about both rising prices and slowing growth, leading many economists to conclude that rate cuts may come as early as March.

Slok said bank write-downs of $400 billion would no doubt be painful, but the impact on lending -- and therefore the economy -- would depend on how widely the losses were spread.

"How much is $400 billion? If it is spread throughout the financial system, it's peanuts. If it's concentrated (among only a few banks), it's serious," he said.

(Editing by Dan Grebler)